Methods of Calculating Depreciation Allocation
There are many methods to calculate depreciation and these all can be grouped into three classes: averaging methods, decreasing contribution methods, and interest computing methods.
There are three methods to allocate depreciable cost under the averaging:
There are three methods to allocate depreciable cost under the decreasing contribution:
- Sum-of-the-years-digits method (SYD)
- Constant percentage method (CPM)
- Double declining balance method (DDB)
The interest computing method uses the sinking fund method (SFM) of depreciation.
Although all the above methods have different amount of allocation (depreciation expenses), the total depreciation should be the same. It is just a matter of allocation of the depreciable cost.
The most important thing to consider is that a company should be able to match revenue against cost. If a company sells its products in a relatively flat during its operation, then it is better for that company to apply the straight-line method of depreciation, because the depreciation expense will also be flat.
If a fixed assets condition is decreased due to the large consumption, and not because of obsolescence, then the company should use production unit method to allocate the depreciation expense. Depreciation of fixed assets is to be charged if a fixed asset is utilized to produce goods. The more goods produced, the greater the depreciation to be charged. If the fixed asset is not utilized, then the depreciation expense for the period is null.
The decreasing methods are used when a fixed asset to contribute greater revenues at the beginning of the period of its utilization. A large amount of depreciation in the early period of fixed asset utilization will be offset by substantial revenue generated in the related period.